The effect upon you, the member
Many of us at some stage in our careers will have been part of a redundancy program, and the initial impact of redundancy can be traumatic in the short term. Very few of us cope well with imposed change and yet most of us eventually come to terms with changes in our lives. For a minority of people, however, redundancy can be a welcomed event for a variety of reasons.
Redundancy gives you the opportunity to develop a thorough grasp of what your entitlements are, and what sort of action is required to meet any potential changes that may have occurred to your retirement and life insurance provision.
It is unlikely that you will have given a lot of thought to this as you started the process of looking for new employment. However, the consequence of redundancy demands a review of what you can realistically do to plug the new gap in your pension planning – even though at the time of your redundancy, you may have received counselling through your employer.
Whether redundancy was welcomed or not, it is essential that you have a clear understanding of what happened to your pension benefit and of any subsequent offers which have been made to you which may affect your pension entitlement.
The effect on your immediate benefits
In relation to any employee benefits package provided by your employer - which will have included the pension scheme - there are a number of key consequences to you having been made redundant.
- You will have ceased to be an active member of your pension scheme and you will have become a preserved member (unless you took your pension benefits in which case you will be a pensioner member). Becoming a preserved member imposes immediate changes to your pension benefits.
- Your pension benefits are ‘preserved’ in real terms and you cannot make any further contributions to your scheme.
- Any ‘death in service’ lump sum benefit that you may have been entitled to as an active member will have ceased – either immediately upon your redundancy or shortly thereafter. Any subsequent lump sum payable on your death is likely to have reduced significantly.
- Any spouse’s or civil partner’s pension paid on your death before retirement might have reduced.
- Any children’s or dependents’ pensions paid on your death before or after retirement might have reduced or ceased altogether.
- Whoever might be classed as your dependants to qualify for benefits on your death, may have changed.
- You may have lost the ability to draw benefits on the grounds of ill-health (if these were available for active members). Some schemes require a minimum period of scheme membership before a member is eligible for ill-health benefits.
- You may be offered incentives to transfer your pension benefits out of the scheme but this may be for a limited period, or the incentives may be offered on a first-come first-served basis.
- You may have lost the ability to retire early. Alternatively, you may have lost access to potentially generous early retirement provisions.
- Depending on how your scheme service was recorded, you may have lost a significant part of your last year’s contributions/service.
Having been made redundant, you will probably no longer receive the steady flow of information about issues governing your pension from your employer and their advisers that you may have previously been used to.
The loss of your future pension benefit rights
Whilst you were an active member of a defined benefit scheme, your pension benefits were linked with your pensionable earnings. However, when you became a preserved member, part or all of your pension benefit instead became linked to inflation:
active member – pension benefits typically linked to earnings
preserved member – pension benefits typically linked to inflation (part or all)
This is important because earnings tend to increase at a faster rate than inflation.
Over a period of years, a pension linked to inflation is more often than not worth less than a pension linked to earnings.
- If earnings grew by an average of 4.0% p.a. over 15 years, each £1,000 would grow to £1,801.
- If over the same period inflation averaged 3.0% p.a, each £1,000 would grow to £1,558.
Some potentially positive ways in which redundancy can help your pension planning
Employers do recognise that making people redundant can be life changing for their employees. Many employers make significant efforts and provide a variety of services to soften the blow of redundancy. Used sensibly and with the right advice, redundancy can be a very powerful way of building up your pension benefit.
A redundancy package may have covered a number of special benefits which would not have been available to you if you were an active member who chose to leave the scheme voluntarily.
These special benefits could have included:
- Counselling - which helped you understand the value of the pension benefits you’ve earned so far, and any changes that were introduced as a result of you ceasing to be an active member.
- Significant cash settlements for those too young to retire early.
- The option to transfer your benefits to a new employer’s scheme on enhanced or more favourable terms within a specific time scale, (e.g. within 12 months of you leaving the scheme, or within 12 months of you joining a new employer).
- The option to transfer your benefits to another pension arrangement (such as a personal pension plan) on enhanced or more favourable terms.
You may have received a redundancy payment from your employer. How much you will have received will depend on how long you were employed. If you manage to find replacement employment quickly, you can choose to spend some of your redundancy payment on a new car or a holiday for example. However, you might consider investing at least some of your redundancy payment towards your overall retirement planning. Invested wisely and with the appropriate advice, the total benefits you may receive at retirement could become bigger than you might have expected to receive before the redundancy.
New rules available since A–Day, (6th April 2006), mean that you can take advantage of the generous annual contribution allowance into a registered pension scheme if you decide to use part of your redundancy payments to make further pension provision.
The effect on the employer’s covenant to support the scheme
There may be a number of reasons an employer makes redundancies. It may sometimes appear to be part of a profit-driven exercise. However, a redundancy program might be part of a steady downsizing of the business because of trading difficulties.
Where the employer only pays the minimum redundancy payment, this could be an indication about the company’s financial situation and its continuing ability to support the pension scheme.
This ability to pay for scheme benefits is called the covenant – it reflects the company’s commitment to the pension scheme and its ability to meet that commitment by coming up with the contributions when they are required - not just now - but many years into the future.
This is not a concern shared by members of public sector pension schemes whose pensions are ‘protected’ by government promises.
Pension benefits, currently, are very expensive to fund, and the value of the members’ scheme benefits can represent a large proportion of the company’s net assets (as pension liabilities now have to appear on their balance sheets). In these circumstances, the pension scheme can drive a weak company into receivership. Before that happens, you should take advice on the wisdom of leaving your pension benefits within the scheme.
If an employer which sponsors a defined benefit scheme goes into administration, scheme members may be eligible for compensation if the scheme is accepted by the Pension Protection Fund (PPF). The PPF is not the full safety net many people believe and you should make yourself familiar with what you might receive in the event that your employer fails and your scheme qualifies for compensation for its members.
As part of its overall financial considerations, even where the future stability of a company is not in question, your former employer may look at the viability of continuing to fund a defined benefit scheme for those employees still in service. It may decide to close the scheme at some point in the future. This could still affect you as a preserved member.
Most pension scheme members would be surprised to learn just how much their employers pay into the pension scheme to fund retirement benefits. Many employers are currently paying 20%-25% of payroll into the pension scheme (which is in addition to any contributions paid by active scheme member). Furthermore, if the scheme is in deficit, the sponsoring employer will be paying extra contributions to fund the shortfall.
Summary & Key Points
When making enquiries about your pension benefit it is very important that you make it clear that you are a preserved member rather than an active member or a pensioner member. Active, preserved and pensioner are different classes of membership of a pension scheme and any definitions and paragraphs contained within your Scheme Rules or scheme literature relating to any benefit may differ considerably between these categories.
Having become a preserved member you should:
- Check what lump sum benefit would be paid on your death as this may have reduced significantly.
- Investigate what spouse’s (or civil partner’s) pension would be paid on your death before retirement as this might have reduced.
- See whether any children’s or dependents’ pensions paid on your death before or after retirement might have reduced or ceased.
- Explore whether your dependants may continue to qualify for benefits on your death (e.g. what happens if you marry/remarry?).
- Check whether there were any changes to ill-health provision or eligibility (if these were available for active members).
- See if there are incentives to transfer your pension benefits out of the scheme.
- Establish if you are able to retire early.
- Keep informed. Your scheme may modify benefits and Rules. Legislation may change. Your circumstances may alter.
- Rules differ from scheme to scheme and are wide and varied in content. Don’t assume that what applies to one of your pension schemes will necessarily apply to others that you may have.
- HMRC impose rules which registered pension schemes must conform to.
People seldom have identical pensions and you should avoid drawing comparisons with colleagues whose circumstances may at first appear the same but could emerge as having significant differences.
This is not an authoritative document. Seek professional advice from an appropriately experienced and qualified adviser.
Redundancy - Defined Benefit Schemes v1.3 Preserved
Last Updated 10/08/2009